U.S. District Court in San Francisco

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The Order Re Summary Judgment issued on June 11, 2014 by Judge Charles R. Breyer of the U.S. District Court for the Northern District of California in the Heller Ehrman LLP bankruptcy case may prove to be a knock-out punch against “unfinished business” claims by insolvent or bankrupt law firms and their trustees. Judge Breyer not only granted summary judgment to four law firms that hired former Heller partners and engaged former Heller clients, but he also distinguished and rejected the 1984 California Court of Appeal decision in Jewel v. Boxer, 156 Cal.App.3d 171 (1984), the case that for years has been the foundation for unfinished business claims involving California law firms.

(For bankruptcy buffs, Judge Breyer’s decision may also have been one of the first to cite the Supreme Court’s Executive Benefits Insurance Agency v. Arkinson decision on de novo review of bankruptcy court decisions.)

The Heller Law Firm Bankruptcy. The Heller litigation arose out of a fairly common scenario when a law firm becomes insolvent or files bankruptcy. After Heller’s bank declared a default, Heller was unable to continue in business and voted to dissolve. Heller notified its clients that it would no longer be able to provide legal services and later filed Chapter 11 bankruptcy. The dissolution plan Heller adopted contained a “Jewel Waiver” purporting to waive any rights under the Jewel v. Boxer case to seek payment for legal fees generated on non-contingency matters after the departure of any Heller attorney.

The Trustee Sues Other Law Firms. After the bankruptcy, the trustee sued various law firms, which had hired Heller partners (called shareholders under Heller’s structure), alleging that under Jewel v. Boxer the Heller estate had property rights in the unfinished hourly matters pending at the time the former Heller lawyers joined other law firms. The trustee alleged that the Jewel Waiver was a fraudulent transfer of Heller’s property rights in those unfinished hourly matters.

The Jewel v. Boxer Case. To give some context, the Jewel case involved a four-partner law firm that voluntarily chose to dissolve into two, two-partner firms. Each new firm continued representing their respective clients under fee agreements entered into between each client and the old law firm. On those facts, the California Court of Appeal in Jewel ruled that by taking that business with them after dissolution, the former partners violated their fiduciary duty not to take any action with respect to unfinished business of the partnership for personal gain. This principle has prompted bankrupt law firms and their trustees to bring so-called “unfinished business” litigation against law firms that hire former partners and take on continuing matters from a failed law firm.

Jewel Distinguished (If Not Extinguished). In Heller, Judge Breyer framed the issue presented this way:

A law firm—and its attorneys—do not own the matters on which they perform their legal services. Their clients do. A client, for whatever reason, may summarily discharge counsel and hire someone else. At that point, the client owes fees only for services performed to the date of discharge, and his former lawyer must, even if fees are in dispute, cease working on the matter and immediately cooperate in the transfer of files to new counsel.

It is in this context that the Court is asked to address a question of first impression: namely, whether a law firm—which has been dissolved by virtue of creditors terminating their financial support, thus rendering it impossible to continue to provide legal services in ongoing matters—is entitled to assert a property interest in hourly fee matters pending at the time of its dissolution.

In the heart of the decision, Judge Breyer distinguished Jewel from the facts in Heller, highlighting “five key, related reasons.” He went even further and, aiming directly at the Jewel decision, stated that the Court “is also of the opinion that the California Supreme Court would likely hold that hourly fee matters are not partnership property and therefore are not ‘unfinished business’ subject to any duty to account.”

I quote from the decision below, but here’s a quick thumbnail of these five key reasons the Court distinguished Jewel:

  1. Cause of dissolution: The dissolution in Jewel was voluntary; in Heller it was forced.
  2. New fee agreements: In Jewel the old firm’s fee agreements were used; in Heller clients signed new agreements with the new firms.
  3. Different firms: In Jewel all partners were from the old firm; in Heller the partners joined pre-existing firms that never owed duties to Heller.
  4. No contingency matters: Jewel did not distinguish between hourly or contingency matters; Heller involved no contingency matters.
  5. Superseding law: Jewel was decided under old Uniform Partnership Act; Heller involved the Revised Uniform Partnership Act.

Given the importance to the decision, here’s Judge Breyer’s discussion of these five reasons:

First, the dissolution of the firm at issue in Jewel was voluntary, while Heller’s dissolution was forced when Bank of America withdrew the firm’s line of credit. This is significant because the partners in Jewel could have, but chose not to, finish representing their clients as or on behalf of the old firm. Here, Heller lacked the financial ability to continue providing legal services to its clients, leaving clients with ongoing matters no choice but to seek new counsel and Heller Shareholders no choice but to seek new employment. Second, in Jewel, “[t]he new firms represented the clients under fee agreements entered into between the client and the old firm.” Id. at 175. Here, the clients signed new retainer agreements with the new firms. Third, in Jewel, the new firms consisted entirely of partners from the old firms: one firm with four partners had become two firms with two partners each. Here, Defendants are preexisting third-party firms that provided substantively new representation, requiring significant resources, personnel, capital, and services well beyond the capacity of either Heller or its individual Shareholders. Where in Jewel, the departed partners continued to have fiduciary duties to each other and the old firm, here, the third-party firms never owed any duty, fiduciary or otherwise, to the dissolved firm. Fourth, Jewel treated hourly fee matters and contingency fee matters as indistinguishable. Here, there are no contingency fee cases at issue. Finally, Jewel was decided in 1984 and thus applied the Uniform Partnership Act (the “UPA”) which the materially different Revised Uniform Partnership Act (the “RUPA”) has since superseded. The RUPA, which applies after 1999 to all California partnerships, allows partners to obtain “reasonable compensation” for helping to wind up partnership business, Cal. Corp. Code § 16401(h), and thus undermines the legal foundation on which Jewel rests.

RUPA, Equity, and Policy. In addition to these five key reasons, Judge Breyer expanded his analysis and concluded that legal, equitable and policy considerations all supported the decision.

  • He found the impact of RUPA on Jewel claims to be “significant” because under RUPA, the duty not to compete with the partnership ends on dissolution, unlike the continuing fiduciary duty not to take action on unfinished partnership business the Jewel court found under the old UPA. Judge Breyer also noted that the California Supreme Court has never ruled on this issue and has cited Jewel only once, in a pre-RUPA case, for an unrelated issue.
  • Turning to the equities, Judge Breyer had little trouble concluding they favored dismissal of the unfinished business claims. As a matter of equity, he stated, “it is simple enough to conclude that the firms that did the work should keep the fees” and further, since clients own the matters, goodwill is not a recognized property interest of law firms.
  • Likewise, the Court found policy considerations supported dismissal. Among other reasons, the trustee’s position would “discourage third-party firms from hiring former partners of dissolved firms and discourage third-party firms from accepting new clients formerly represented by dissolved firms.”  This “would all but force former Heller clients to retain new counsel with no connection to Heller or their matters,” contrary to “the primacy of the rights of clients over those of lawyers.” Clients should have access to a market for legal services “unencumbered by quarrelsome claims of disgruntled attorneys and their creditors.”

A Post-Heller World. It’s not an overstatement to say that the Heller decision essentially dismantles the applicability of Jewel v. Boxer to insolvent or bankrupt law firms. If upheld after any appeal and followed by other courts, the Heller decision could mark the end of California “unfinished business” claims against law firms in the non-contingency, hourly fee context. There may yet be more twists and turns in the Heller case and in other law firm bankruptcies, so stay tuned for further developments.